Gold to Extend Losses as Profit-Taking Continues into Year-End

Written By McCool on Friday, December 17, 2010 | 6:10 PM

Fundamental Forecast for Gold: Bearish

As we suspected, gold prices declined last week as traders continued to unwind bets linked to the reboot of US quantitative easing (known as “QE2”), extending a trend established in early November when the Federal Reserve made the official its $600 billion expansion of asset purchases. The increase matched what investors priced in over the preceding months – a process that produced sharp rallies in stocks, Treasury bonds and gold while weighing on the US Dollar against the spectrum of major currencies – opening the door for profit-taking.

Strictly speaking, gold doesn’t neatly fit into the “risk” or “safety” side of the dichotomy that has ruled financial markets in the aftermath of the 2008 crisis. Indeed, the metal has been equally sought as a store of value by those thinking the recovery will gain momentum, unleashing catastrophic inflation, and those thinking it will flounder, erasing paper gains build up since asset prices started to rebound in early 2009. However, the primacy of QE expectations as the central theme since August put a spotlight on the metal’s allure as an inflation hedge, sending prices higher in the months leading up to the QE2 announcement. Indeed, gold’s correlation with US breakeven rates – a measure of priced-in inflation expectations – surged to the highest in over year in the run-up to November’s FOMC rate decision.

With the Fed delivering no substantive changes in monetary policy at last week’s follow-up meeting to November’s announcement, there seem to be no significant barriers to continued profit-taking on QE2-linked positions in the final two weeks of the year. As such, the yellow metal looks set to continue lower for the time being, with traders looking ahead toward the holidays and unlikely to re-evaluate the key drivers behind asset prices until the calendar rolls over into 2011.

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